Asset price bubbles in a monetary union: Mind the convergence gap

We estimate logit models of housing and stock price bubbles, using panel data for 15 EU countries for the time period 1995-2014, covering a wide set of determinants: monetary, macroeconomic, demographic, institutional and those arising from monetary integration. Our key finding is that higher degree of real convergence diminishes the probability of a bubble in the housing market caused by a fall in interest rates after joining the monetary union. Applying these results to three Central European countries (the Czech Republic, Hungary and Poland) we conclude that, given the existing economic distance in terms of per capita GDP between the three countries and the top eurozone performers, joining the monetary union would ceteris paribus significantly increase the probability of house price bubbles in those countries. This result suggests that the optimum currency area framework should be broadened to include the degree of real convergence between the monetary union and the acceding country.